Rosetta Genomics: What Happens When The Music Ends?

| About: Rosetta Genomics (ROSG-OLD)
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Rosetta Genomics (NASDAQ:ROSG-OLD), a cancer diagnostics company, was valued at 324x trailing twelve months (NYSE:TTM) sales as of the close on Friday, topping a 5x ttm sales multiple considered 'standard' in their industry. The disparity between the benchmark and unusually high sales multiple assigned to Rosetta could (mistakenly) be attributed to a 63% drop in revenues year-over-year, though a closer look suggests this may be immaterial.

Rosetta's revenues in fiscal year 2011 were just $103,000 compared to $279,000 the year prior. In 2009, sales totaled $150,000, according to the company's annual report. More concerning, management burned through more than $10MM on continuing operations, adding to an $85 Million accumulated deficit. Indeed, as of the year-end, the company stood in a vulnerable position with $0.884MM in cash and equivalents, a $638,000 working capital deficit, and no receivables or substantial prospects, whatsoever.

Roughly one and one half months later Rosetta publishing their 2011 annual report, the company's shares are one of the most actively-traded issues on the NASDAQ. Notwithstanding poor fundamentals, poor performance, or negligent dilution that reduced insider ownership to less than 1% of the company.

On May 16th, Rosetta announced that Medicare approved coverage of one of the company's diagnostic tests, 'miRview® mets²'. The rally that ensued, was more than likely perpetuated by an unusually low number of shares available or 'floating' due to a 3-day settlement typical with new issues, like the 1-for-15 reverse split that took effect May 15th. Essentially, if you were a holder of Rosetta's common stock prior to the reverse split 'effect date' of May 15th, chances are your shares were 'restricted' from being sold into the market due to the settlement rule. This means that at least until the 18th, the 'supply' of stock was underrepresented. All else being equal, the economics of supply and demand would have it that a decrease in supply leads to a higher price - precisely what occurred.

As shares rallied on the Medicare reimbursement news, Rosetta announced an offering of 632,057 shares at $3.50, netting the company ~$2MM and postponing an embarrassing bankruptcy. One week later, another offering was announced, this time priced at $11.50 a share, to keep pace with a rising 'market price'. Regardless of the market price, the offerings were both priced at steep discounts. In the process, management effectively gave up 50% of the company in exchange for $8MM. This implies a valuation of $16MM or $6.54 a share, less than half the last quoted market price.

Medicare reimbursement was, and is, a major milestone for the company. But the valuation investors have assigned to Rosetta is far too forward-looking - a valuation that pegs very high hopes to future sales of product(s) that have sold dismally for three consecutive years. For Rosetta to be valued in line with peers in its segment on a price-to-sales basis, it would need to grow at a compounded rate of 218% over the next 5 years. This assumes that Rosetta will not dilute its shares (which is inevitable, since burn rate >$10M/annum) or require a large capital investment in order to better market its product offering (also an unreasonable assumption).

Further, the sheer volume seen the last few weeks of trading suggest investors need exercise caution - whenever a stock trades 5X or 10X its float in one session, you can be sure traders are at play and not institutions or long-term investors of any sort. It's best to relate this to a game of musical chairs: once the music stops you don't want to be the only one without a chair - of course the consequence in this case is that you'll part ways with your money. And even if you enjoy the occasional game of musical chairs, you'll be glad you found a chair before the Rosetta music ends. Investors, take precaution.

Disclosure: I am short ROSG-OLD.